Economics Webinar - Financing from Workers: Can Labor Market Power Mitigate Financial Frictions?

We show that borrowing from workers through reduced compensation provides firms a mechanism to partially offset financial distress when they have labor market power. Using Census employer-employee data, we find that workers in high-leverage firms experience significantly slower earnings growth following an unexpected deflation shock that increases the real burden of firms' nominal debt. To quantify this mechanism, we develop a heterogeneous firm model incorporating both labor market power and default risk. When calibrated to US firm financing patterns and labor market elasticities, our model shows that labor market power substantially reduces the impact of financial distress on firms. Our findings highlight an important but understudied channel of borrowing from workers through which labor market imperfections affect firm dynamics.